Endowment Effect

What is the endowment effect?

The endowment effect describes buyers' tendency to value a good higher once they own it. Therefore, people demand more money for giving up an object than they would be willing to pay (Kahneman et al., 1991). 

Explanation

In a study, researchers offered participants a lottery ticket or $2. Later, the researchers introduced the option of exchanging the money for a lottery ticket or vice versa.

Most of the participants did not want to trade.

This event was the case even though the money had a higher risk-free value than the lottery ticket (Knetsch & Sinden, 1984). Once the participants acquired a sense of attachment and belonging to the object, they were unwilling to give it up since the loss of selling it (loss aversion) was more important than the actual selling price.

How to use it?

Several strategies can help foster a sense of customer ownership or attachment to products.

One of the most common tactics is offering a free trial (for a subscription or a free sample of your product).

Recently, buy-now-pay-later services have used a similar approach to give consumers the sense that they already "owned" a specific product in the past.

Lastly, trying out products like clothes or phones allows customers to imagine owning them much more than merely seeing them on the shelf.

What are the disadvantages of the endowment effect?

Offers can be poorly timed

If a company endows customers for an extended time, it might lose revenue. However, if the period is too short, the attachment might not become strong, and customers may reject the new product.

Therefore, it is crucial to find the right time span.

Customers are reluctant to switch to a new product

It can be challenging to convince customers to change to a new product if they have already fostered an attachment to the competitor's product.

Additionally, the endowment effect also applies to sellers, so remember when setting up a pricing strategy.

Further reading

"What your customer wants and can't tell you: Unlocking consumer decisions with the science of behavioral economics" Melanie Palmer

"Why Buyers and Sellers Inherently Disagree on What Things Are Worth" Carey K. Morewedge